Costs of Capital and Capital Structure Review - Essay Example

Finance Name Course Date Tutor Finance Article Review: Costs of Capital and Capital Structure Introduction Capital structure refers to percentages for capital within the work environment in an enterprise by method. As such, two forms exist and they are equity and debt forms of capital. Both of them have their benefits and a large part of wise corporate means of stewarding. Management usually tries to find the right means of capital structure. On one hand, the cost of capital is the opportunity costs which are gotten when making a specific investment. This is a reference to the rate of return which may be earned through placing the same monies into a different investment that had equal risk. Therefore, the costs of capital refer to the rate of return which is needed in order to persuade an investor to make a provided investment (Faulkender & Petersen, 2004). The article under analysis for the first part is written by Michael Faulkendber on whether the source of capital affects capital structure. According to the article, prior workings on leverage assume capital presence which depends on attributes of the organization. The examination of this intuition finds the firms which provide access to the bonds available to the public measured through high debt ratings. Companies have a different rating in fundamental means, even though the differences do not provide an explanation on the findings. Even after the control of characteristics of the company that try the observed structure of capital and instrumentation for the potential endo-geneity for the rating, as the companies end up with more debt. The right capital structure is a reference to the main decision for enterprises in order to be considered by the companies to maximize on the wealth of shareholders and sustaining development. The decision for structuring the decisions for capital is one of the most significant. It has long been in debate as to whether the capital structures are influential to the costs for the capital and the value of the firm. capital structure theories and their linkage to the value of the firm has been problematic for corporate finance and literature as both Miller and Modigliani claim that under the market assumptions, there are no costs for bankruptcy as the capital markets are not frictional in the event that without taxation, the value of the firm is independent as there capital form. Debts can reduce the taxation which is done and in a manner where the capital structure concerns enterprise in this manner (Faulkender & Petersen, 2004). How company gets finance depends on the providers of the fund and the management of the organization. In the event, debt and equity wrongly mixed would mean the enterprise would be badly affected. As such, this research would aspire in the consolidation of debates for the links for the performance of the firms and the structure of the main theory. The decision to finance considers facilitation of growth and survival as concerns business enterprises and these call for requests to channel directives of enterprises for the realization of direct financing as a trial for the protection of the interests of shareholders. This is an implication of effective means of the financial organizing via consolidation of the main structure of management in the maximization of shareholder wealth. Companies could finance investment decisions through equity and debt. The financial management is facing hardships in determination of an optimal capital structure. The main structure of capital would require a minimum weighted cost for the capital in order to maximize upon value for corporations. As such, the means of capital structure and the effect for performance would be investigated in time using research through different scenarios and results. The decision of the firm as concerns source of capital is going to affect its competitiveness. As such, a company should use the right mixture of debt and equity which is going to maximize the profit making abilities during the long term (Faulkender & Petersen, 2004). In the article, the author examines the manner in which the organizations which choose the capital mean. In the combinations for literature in optimal means of choices which concern leverage in literature for the main choices pertaining to leverage with the ongoing literature that is based on constraints, it is possible to better explain the patterns as they are observed in the publicly traded organizations. In the case of small and private organizations, it would be easy to see they are restricted by their credit. There is not a lot of information that is out there about these firms and what they should do. The miniature size and the cost for information collection may be high. When one examines the main companies of public trading, the landscape is going to be different. The organizations are not only bigger but the regulatory needs for the firms concerning the issuing of main equity also means there is information available or other secondary sources. On the other hand, even with this context, the capital structure decisions for these organizations are limited by main market. The fact organizations have to borrow from their representatives have a lower amount of leverage is simple mathematics. The costs to watch the imperfects means of contracting which is going to raise the costs of debt capital for the organizations which lowers the desired amount of leverage. If the monitoring and contraction of the solution in an insufficient manner, the firms would then have to come face to face with constraints and not capital. The surprising thing is variance that is not captured according traditional means with the texts of capital structure. According to the article, even after control for the organization’s attributes and heterogeneity which is not observed at the levels of difference considering the leverage is high, so it will not go the distance in the explanation of the perceived underleverage on which the author of the article focused upon (Faulkender & Petersen, 2004). The findings also increase the possibility which may shock particular phases of the capital markets and affect the organization in different ways. Slovin and Sushka say that organizations whose banks may suffer from a shock to capital the way which is from the demand of the firm for capital may impact the financing of the organization. If as per speculation, and the instrumental variable results imply, organizations are not easily moved from private markets are for the debt markets and shock to the banking market would have better shocks for the main bond market. At the same time, since, the organization might not have the adequate access for the markets for the public, the effect on their finances are going to be much larger. Article Review: Study of Performance Evaluation of a Manufacturing Company Increasing intensity as concerns the universal business competition has made firms use different methods of performance assessment in the evaluation of their finances. In general, performance assessment for companies is assessed in the scenario concerning financial analysis. Performance in the financial department is broad for economic growth, productivity and return, the utilization of methods within performance evaluation would be an adequate way for corporations. According to the article, accounting principles are great tools for the execution and implement of practice management as a plan. In the present’s competitive environment, the evaluation of the financial performance is important for corporations which are based within the manufacturing sector (Mohammadi & Afhan, 2012). Analysis of financial performance is a reflection of financial position and the respective levels of competition within the same sectors and knowledge for centers of cost for the organization. Investors can try out the evaluation through accounting analysis as required in the planning and decisions. The study in the article was concerning financial analysis of the investment company Malaysia in the time period from 2009 to 2011. This was evaluated by the use of financial ratios and the findings were that the overall performance of the company reduced markedly for the last year analysis. As such, the study provides emphasis on accounting assists the decision makers when it comes to the evaluation of the performance of the corporation and determining the future obligations for making better investment decisions. For a number of years studies have shown the benefits as related to the financial ratios. Research has shown that ratio analyses response for an amount of information that is gotten in financial statements and issues pertaining to compare the amounts of companies with different aspects. By utilizing them, both the investors and analysts would be a summary and analysis of the quantitative information in order to gain momentous information for providing operations of the firm, and investigating the situation within the sector to make adequate decisions (Mohammadi & Afhan, 2012). It is the opinion of the article that strong and weak points of the firm as concerns growth, profitability and liquidity can be revealed with the use of financial ratios. This means whether the company is operating in the right way or if corrective methods are needed. At the same time, ratios also make it easy to audit and estimate bankruptcy as well as, ranking the company and approving a loan which determines the value of the company and rates the bond. Required analysis is done through comparisons with behavior for the comparison of criteria showing the industry success which would be done in the same sector. The article also suggests that different empirical studies were done in order to create patterns for financial ratios in the corporate sense. The principal objective for the research in most cases allow for the large methods of information for the financial methods. The study made use of the quantitative research methodology (Mohammadi & Afhan, 2012). So as to look into the main performance, accounting information considered from the reports coming in from the KNM Group Berhad. As such, ith deals with the production assembly of processing materials for oil and gas industries using the group corporations. As such, it is divided into the company and the group department. At the start, vertical and horizontal analyses for the income statements and the balance sheets were done. In order to evaluate the link between different information concerning the income statements and the balance sheet, the financial ratios was assessed. The information was also evaluated through Microsoft packages of Excel, the results were given by the means of descriptive statistics and frequency counts (Mohammadi & Afhan, 2012). According to the text, the analyses were divided into the group and the company. Now the group as per 2009 in the ratio analysis seems to have a stronger financial position and sufficient liquidity for maintaining business operations. Group was also more able to pay the current liabilities with the current assets in the following year. During 2010 and 2011, the information from the article shows that it was not able to return on investment in a quick manner. On the other hand, the main ability was collecting revenue from clients. All of the years which were represented had similar ratings but not very notable because of the rates and the rates the group may convert receivables into revenue during the period. On the other hand the company had a large amount as per 2009 which relates to not satisfactory as it is an indication that the credit is too high. This amount though seems to be lower in 2010 and 2011 and that is an indication the corporation would not collect from credit customers in an effective manner. The interest earned factor is for the organization and corporation implies that in 2009, the profits from the transactions could allow interest expenses had a better ability to pay for interest when compared to previous years. The financial ratios for returns at this time is an illustration of reasonable sales revenue, earned during this time. As of 2009, though there were more sales revenue providing profit to enterprise enter the company and less money was incorporated through the expenses. The corporate was also provide profit via the sales as per the duration (Mohammadi & Afhan, 2012). According to the study, performances of one of the manufacturing department companies were measured in a period from 2009 to 2011. As per the assessment, it would be considered during the 2011, that the company was not operating appropriately and the overall performance in the way of profitability and credit quality went down significantly because of deterioration for the operating environments. As such, the revenue and net profits during the final year reduced because of a decrease in the order intakes and the sales. As such, the shareholders did not get the best results on their dividends for 2011 as compared to the previous years. Financial planning for the Abu Dhabi Islamic Bank: Capital Structure and costs of capital The Abu Dhabi Islamic bank is an Islamic bank which is based in the city of Abu Dhabi in the United Arab Emirates. The banking institution is characterized by fast growth and high earning growth rates as well as loan to deposit ration. As evaluated in the previous text, capital structure and cost of capital is essential in the firm. The tradeoff theory is an assumption that capital structure would move toward the best level of leverage as thought out by tax savings merit for the costs of financial stress. As confirmed in the previous text, other research in a number of markets have found the tradeoff theory to be true. Apparently, the statistical relationship between structure and previous debt factors is positively linked. As such, research is testing the capital structure reasoning for institutional performance and better leveraging for the institutions. Corporations are able to use more debt in the enhancement of their financial performance as the capability of debts allow the management to be better on productivity which cancels out insolvency. It has been found that important which test the relationship between the size of the firm and performance. The research which considers the economics if scale have found size affects performance because large entities are better at reducing the costs for their operations by virtue of their subsidized supply and manufacturing decreases. As such, the Islamic banking capital structure for the gulf nations appears to have similar considerations about regulation because of capital adequacies. As such, the return on assets ratio as a performance measurement method is not positively linked to the financial leveraging as considered by other research personnel. The return on assets measurement is either positively linked to ratio of the equity to assets. That means the more efficient banks such as the Abu Dhabi Islamic Bank ought to utilize less leverage as compared to its peers in the industry. This is aligned with research from the article. The analysis also shows a good level of correlation between the size of the institution and the performance of the finances for both the Islamic and conventional banks. The Abu Dhabi Islamic bank should formulate policies which make the commercial debt cheaper and reduce the cost of operations. The banks would then be able to acquire better financing by acquisition of debt which is going to assist in improving the capital and performance. They may also decide to reduce the level of their interest rates through the collaboration of the central banks in order to attract more investors who will inject more funds. These funds would then be used for onward lending as increased interest income that would be part of the earnings. Focus should also be made for the financial deepening and attraction of the investors who would then improve on their performance. Capital management is going to be crucial as the competition tends to increase within the region. One of the main priorities as well would be the reduction of the cost of capital in the defense of the market share and competing in an effective manner against the larger conventional peers, whom are ahead with non-equity high priority transactions within the capital markets. The time for the Islamic institutions to take action is the present by use of prudent financial planning and optimization, as liquidity is present within this part of the capital structure. However, it is important for the banking institution to study other variables such as working capital management, client satisfaction, corporate governance and the payout ratio for dividends. It would also be recommended that a study be done on the listed firms which are on the stock exchange. The purpose here is to have a main view of the effects pertaining to capital structure and financial performance for organizations as per the covering of both the private and public institutions. Financial performance evaluation According to the financial performance evaluation, we have seen the importance of ratios in determining the financial health of a corporation. The increasing level of competition considering the market scene has made corporations that align different means of assessment for evaluating their status. In this way, the performance evaluation for firms is conducted within a context of financial analysis. It has become the benchmarking tool to assess the level of business that a company is able to conduct and how it fares within its own industry and even across markets. Not only do the financial indicators assess the level of business that a firm would be able to process or it’s ranking in the market, but also the predictive factors of business for its future. This could be anything from the short to long term. For example the liquidity analysis is meant for the short term showing current position and in the article evaluated in the early text, it was meant to reveal the reactive attributes of a corporation in the event of need to finance investments or conduct certain transactions. There was also return on investments that show the ability of the company to be profitable even in the long run. Now, financial ratios can be profitable even in the case of banking institutions like the Abu Dhabi Islamic Bank. According to information on financials of the Abu Dhabi Islamic Bank, it seems that it has been through slump during the past six or seven years. 2009 to 2010, the return on assets were 0.13 and 1.47. The figure has improved a bit to be currently be at 1.65 for the past year and it seems to be stabilizing. The return on equity percentage reached 1.45 percent in 2009 and it is currently at 13.25. It is not at the figure of 40.11 percent during 2005, but this is a step in the right direction. Clearly, the bank had suffered due to the recession and is only now recovering. It is through the use of these financial ratios that we are able to diagnose conditions in financial institutions before things get out of hand. From ADIB’s example, it is evident that internal operations can nose dive within a short time which can lead to closure. These financial ratios are essential if one wants to know a problem before it becomes too much to handle, in order to place the right corrective measures in effect. References Mohammadi, M., Afhan, M. (2012). An Empirical Study of Financial Performance Evaluation of a Malaysian Manufacturing Company. Academica Science Journal. Economica Series, No. 1 (1) Faulkender, M., Petersen, M. (2004). Does the Source of Capital Affect Capital Structure? Forthcoming Review of Financial Studies. Retrieved from http://www.kellogg.northwestern.edu/faculty/petersen/htm/papers/published/bankbond.pd f Read More